What Is a Non-Conforming Mortgage?
A non-conforming mortgage is a home loan that does not meet the criteria set by government-sponsored enterprises (GSE) such as Fannie Mae and Freddie Mac. This means these loans cannot be packaged and resold to these agencies. The criteria set by these GSEs include maximum loan amounts, property types, down payment requirements, and credit score benchmarks.
For comparison, a conforming mortgage aligns with all GSE guidelines and is therefore eligible for resale to entities like Fannie Mae or Freddie Mac.
Key Takeaways
- Distinct Regulations: A non-conforming mortgage does not comply with the strict GSE guidelines and, as a result, cannot be sold to these agencies.
- Higher Interest Rates: Due to the increased risk associated with non-conforming mortgages, they often carry higher interest rates than conforming loans.
- Jumbo Mortgages: Loans that exceed the conforming loan limit fall under the non-conforming category and are typically referred to as jumbo mortgages.
- Broader Criteria: Other aspects such as loan-to-value ratio, down payment size, debt-to-income ratio, credit score, credit history, and required documentation can also classify a loan as non-conforming.
Understanding Non-Conforming Mortgages
Non-conforming mortgages are not inferior because of risk or complexity, but because they do not adhere to GSE guidelines, making them harder to sell. This is why financial institutions often impose higher interest rates on such loans.
While private banks may originate most mortgages, many end up in the portfolios of Fannie Mae and Freddie Mac. These institutions buy loans from banks to package them into mortgage-backed securities (MBS) for the secondary market. However, they can only buy loans that meet their specified criteria.
Banks use the capital generated from mortgage sales to fund new loans at prevailing interest rates. Fannie Mae and Freddie Mac have stringent federal rules limiting their purchases to relatively low-risk conforming loans, making these favorable for banks to sell.
In contrast, mortgages that do not meet these standards pose higher risks and cannot easily be sold. Such non-conforming loans either remain in the issuing bank’s portfolio or are sold to entities specialized in managing secondary market non-conforming loans.
Types of Non-Conforming Mortgages
There are multiple borrower scenarios and loan types that may classify as non-conforming according to Fannie Mae and Freddie Mac criteria.
Perhaps the most familiar type of non-conforming mortgage is the jumbo mortgage—loans exceeding the conforming loan limit. As of 2024, this limit is $766,550 in most U.S. counties, but it can reach up to $1,149,825 in high-cost regions like New York City or San Francisco.
Non-conforming doesn’t only mean jumbo. For example, a low down payment can classify a mortgage as non-conforming. The threshold might be 10% for conventional loans or as low as 3% for Federal Housing Administration (FHA) loans.
Important Considerations
As of May 2023, changes in upfront fees for Fannie Mae and Freddie Mac loans mean that borrowers with higher credit scores, such as those above 740, incur higher fees, while those with lower scores, like under 640, may see decreased fees. Additionally, down payments will influence these fees—the larger the down payment, the lower the fees, although linked to the borrower’s credit score. Fannie Mae provides detailed guidelines via their Loan-Level Price Adjustments.
Moreover, a borrower’s debt-to-income ratio (DTI)—typically required to be 43% or lower for conforming loans—and credit score, usually 660 or higher, play crucial roles in determining loan conformity.
Property type can also affect mortgage classification. Condo buyers, for instance, may find their desired property is non-conforming if the complex is considered non-warrantable. Factors contributing to this status include a single entity owning over 10% of units, non-owner occupancy exceeding 50%, more than 25% of space used for commercial purposes, or ongoing homeowners association (HOA) litigation.
Related Terms: conforming mortgage, mortgage-backed securities, secondary market, loan-to-value ratio, debt-to-income ratio.
References
- Federal Housing Finance Agency. “FHFA Announces Conforming Loan Limit Values for 2024”.
- Fannie Mae. “Loan-Level Price Adjustment Matrix”, Page 2.
- Consumer Financial Protection Bureau. “Qualified Mortgage Definition under the Truth in Lending Act (Regulation Z): General QM Loan Definition”.
